Market regulator Securities and Exchange Board of India, or SEBI, has mandated fund houses to adopt full-trail model in all schemes with immediate effect.

Incentive for Systematic Investment Plans, or SIP, inflows

The regulator has permitted upfronting (paying the trail upfront at the time of transaction) in SIP inflows for new investors coming in the industry. Registrar and transfer agents will have to identify unique investors through Permanent Account Number at the industry level once SEBI comes out with detailed guidelines on this.

In the meantime, ‘upfronting of trail’ will be allowed only in SIP inflows for new individual investors investing up to Rs 5,000 per investor, per mutual fund across all schemes of a fund house. Identification of new investor will be at the fund house level. Theoretically, distributors can get ‘trail upfront’ for inflows exceeding this threshold of Rs 5,000 if they split applications across different fund houses as the rule is applicable per AMC, per investor. Practically, it will be an operational hurdle though. It increases the compliance cost for fund houses. Nevertheless, this is an interim measure provided by SEBI until all R&T systems are integrated to identify unique investors. Meanwhile, SEBI has issued the following rules for asset management firms to facilitate this incentive:

Upfronting of trail commission will be up to 1% of the total SIP inflows for a maximum period of 3 years and will be paid from AMC books.

The commission will be amortized on daily basis to the scheme over the period for which the payment has been made. A complete audit trail for payments made from the AMCs’ books and amortized to schemes thereafter should be made available for inspection.

The commission will have to be charged to the scheme as ‘commissions’ and should also account for computing the TER differential between regular and direct plans in each scheme.

The commission paid will be recovered on pro-rata basis from distributors, if the SIP is not continued for the period for which the commission is paid.

In case of misuse of the carve out for SIPs, the same would be discontinued and appropriate action would be taken against the errant participants.

All fees and expenses charged in a direct plan (in percentage terms) under various heads including the investment and advisory fee shall not exceed the fees and expenses charged under such heads in a regular plan.

No pass back, either directly or indirectly, shall be given by MFs/ AMCs/ Distributors to investors.

Training sessions and programmes conducted for distributors should continue and should not be misused for providing any reward or non-cash incentive to the distributors.

Full-trail model to impact new entrants

Industry experts believe that the transition to all-trail model could impact new/start up advisers who do not have deep pockets. Let’s look at this example. Let’s assume an established distributor has AUM of Rs 100 crore with SIP book of Rs 1 crore per month. On a SIP book of Rs 1 crore, she earns Rs 6,667 per month, assuming 80 basis trail commission (1,00,00,000*0.80%/12). Since the established distributor has a healthy existing AUM, he/she is not impacted much. On the other hand, a startup IFA having a SIP book Rs 10 lakh earns just Rs 666 per month.

Mumbai based adviser Ritesh Sheth whose firm Tejas Consultancy manages AUM of Rs 450 crore in mutual fund recommends that the industry should establish an incentive structure which incentives new Association of Mutual Funds in India (AMFI) Registration Number, or ARN, licenses. “The incentive structure could differ depending on the ageing of ARN for different categories (Individuals, Corporate, Senior Citizens, etc.). For instance, individual ARNs that have not completed five years can be incentivized higher as compared to an ARN which in existence since 10 years. This will allow new independent financial advisers to have a roadmap for their business.”

Some disagree. “I have seen IFAs operating since 15 years in mutual funds who have only built an AUM of Rs 10-15 crore so far. On the other hand, some new IFAs have built AUM of Rs 50 crore in 5 years. It depends on how focused the IFA is,” observes the chief executive officer of a mid-sized fund houses wishing anonymity.

The discretion to opt for ‘upfronting of trail’ is with distributors. Many established mutual fund distributors have either already moved to full-trail model or are in the process of doing so.

Thrust on smaller town remains

Distributors from smaller towns have something to cheer about. The additional incentive for getting ‘individual investor’ inflows from beyond 30 cities remains, though it can be paid only in the form of trail. So far, this incentive was applicable for all inflows (including institutional inflows). Till the industry comes out with a definition for ‘retail investors’, distributors will be eligible for ‘individual investor’ inflows from B30 locations (in the form of trail only), irrespective of the ticket size. Individual investor includes both retail and high net worth individual, or, HNI. Currently, AMFI defines HNIs as individuals investing Rs 5 lakh and above.

All-trail model beneficial for industry

Fund officials are unanimous in their verdict on SEBI’s new move. “In the long run, the structure is in the interest of all stakeholders. As client’s succeed, so will distributors. There will be cash flow mismatch for set ups which depended on upfront. They will need some time to adapt. That said, a majority of distributors have moved to all-trail model already. New distributors will now have to focus on increasing volume,” observes Himanshu Vyapak, Deputy CEO, Reliance Nippon Life Mutual Fund.

Fund officials believe that while SEBI’s new rule could cause short term hiccups, it will be beneficial in the long run. “When the entry loads were abolished, there was a panic that it will impact the growth of the industry severely. However, the industry has adapted itself and has grown multifold. Similarly, I believe the new rules will certainly affect the profitability of distributors in the short run. Having said that, distributors should now focus on increasing volumes by adopting technology. The exclusion of non-individual investors for B30 inventive will sharpen the focus of the industry towards retail," says G Pradeepkumar, CEO, Union Mutual Fund.

Jimmy Patel, CEO, Quantum Mutual Fund, believes that SEBI’s move will boost inflows in SIPs. “Upfronting of trail in SIPs for new retail investors will help new/start up distributors as well as large distributors incentive their sales force for focusing on getting SIP inflows. It takes care of the cash flows. Though the margins of distributors will go down, it will give a new thrust towards SIPs. The industry will benefit from this as distributors will focus on SIP assets, which are sticky.”

Inflows through SIPs are growing at a robust pace. In FY 2016-17, the industry received SIP inflows of Rs 43,921 crore which increased to Rs 67,190 crore in FY2017-18, a jump of 53%. The industry now has 2.44 crore SIP folios.

Swarup Mohanty, Chief Executive Officer, Mirae Asset Mutual Fund, believes that the new commission structure plugs some loopholes existing in the past structure. “The erstwhile regime of B15 incentive had scope for churn. The correct parameter to judge the growth in B15 markets is AUM and not necessarily folios. I believe trail is the right form of incentivizing distributors as it is linked to the underlying assets. Now, there will be a sharper focus on expanding the industry by getting new investors in the industry.”

The way ahead

Clearly, new distributors joining the MF fold have to adopt technology, bring in some capital, diversify their source of revenues and keep costs low until they build a reasonable AUM which takes care of their cash flows. It remains to be seen how new distributors cope with all-trail structure.